By Timothy Anderson, timothyanderson2005@gmail.com
On May 25, Rachel Lomax, Deputy Governor of the Bank of England paid BritCham a visit, participating in the monthly Business Forum.
Professing a keen interest in the affairs of developing economies stemming from her time at the World Bank, Mrs. Lomax noted China continues to face numerous challenges in moving towards a full market approach with flexible exchange rates, liberated capital accounts and fully developed market based monetary instruments. And as participants noted, the Chinese banking sector in general does face challenges.
Five years ago, the ‘Big 4’ banks in China each declared non-performing loans (NPLs) of between 40-60%. The risk remains high that the previous situation of massive NPLs could repeat itself in the future – and risk management is therefore a hot issue in China.
“Chinese banks may claim only 5% bad debts exist, but this is largely thanks to the massive capital investment from the state for the purpose of preparing the banks for IPOs”, intoned Michael Askew of Business Development Bank. “Yet there has been no fundamental change in loan behaviour of the big Chinese banks.”
It doesn’t take long to pile up NPL loans of 20% or more – with many Chinese banks already fast accumulating loans. Banks build up assets intentionally to manage their bad debt ratio. However, if these assets are not of a particularly high quality, the NPL problem is potentially exacerbated.
"The understanding of rules and what is possible and not possible in China
is still very much developing and maturing", noted Nick Harrison of Lloyds
TSB. "This means there is a lot still to learn and discover."
So how is the Chinese banking sector distinct, and what are the consequences?
“Financial intermediaries - such as the stock market and bond market - are underdeveloped in China, so they simply do not play the same role that they do in developed economies”, noted Charles Li of The Royal Bank of Scotland. “Consequently, Chinese banks bear a much higher burden than banks in the West – a fundamental difference between the two – so it is not fair to expect that banks in China can run at 5% NPL level. The role of the banks is to provide the system with liquidity - if they don’t, the system crashes.”
However, an adequate assessment of who not to support seems to not be happening, which remains a significant problem.
“As in the past, policy lending is still prevalent in China”, noted Michael Askew. “The government in one form or another often decrees who is to be lent to and the banks lend the money. The capacity to apply sophisticated risk management tools and techniques in such scenarios is obviously quite limited.”
It was noted that credit risk managers (CRMs) are supposed to oversee, account for, and assess if and when loans are NPL. However in Chinese banks, the person selling the loans and person doing credit risk management often don’t interact, which is a problem since CRMs acting alone cannot adequately assess if loans are NPL.
Foreign banks, with only 1-2% market share, have limited influence over regulations in China. This market share and influence will increase if and when foreign banks are allowed to engage in RMB borrowing with individuals and enter the retail-banking sector – something the government promises will happen.
Rachel Lomax noted that as China is likely to face growing inflationary and exchange rate pressure, its reform agenda needs to move quickly. This is an issue attracting much international attention since Chinese inflation contributes to global inflationary pressures – and the Chinese economy does have the critical mass to impact the global economy.
Originally published in the July 2006 issue of ‘The Beat’, the monthly magazine of The British Chamber of Commerce in Shanghai.
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